TEXT-S&P rates Leslie's Poolmart proposed loan 'B'

-- U.S. pool supply retailer Leslie's Poolmart Inc. is refinancing its existing term loan and paying a dividend to shareholders.

-- We are assigning a 'B' issue-level rating to the company's proposed seven-year $575 million term loan.

-- We are affirming our 'B' corporate credit rating on the company.

-- The stable outlook reflects our expectation that the company will continue to open new stores and increase profits over the next 12 months and although credit metrics could improve modestly during that period, we anticipate credit ratios will remain reflective of a highly leveraged financial risk profile.

At the same time, we assigned a 'B' issue-level rating with a '4' recovery rating to the company's $575 million senior secured term loan B. The '4' recovery rating indicates expectations for average (30%-50%) recovery in the event of default.

Leslie's plans to use the proceeds from the debt facilities to refinance its existing term loan and pay a $305 million dividend to shareholders. We will withdraw our rating on the existing term loan upon repayment.

Rationale

The rating action reflects Standard & Poor's reassessment of Leslie's business risk profile to "fair" from "weak." The financial risk profile remains "highly leveraged." The revision of the business risk profile is due to the company's ability to grow market share, despite weak consumer spending and a stagnant housing market, through its diverse product offerings and staff technical expertise. We believe Leslie's has a good market position in the highly fragmented, seasonal pool-supply industry, which is riddled with competition from numerous local stores, regional chains, home improvement centers, and discounters.

We expect future growth in profitability due to stable performance at the company's existing store base, coupled with new store growth. Even with this, we continue to view the company's financial risk profile as highly leveraged. At Sept. 30, 2012, pro forma for the transaction, total debt to EBITDA increases to approximately the mid-7x area from the high-5x area in the prior-year period. EBITDA interest coverage is likely to weaken to 1.7x from 2.1x. We also anticipate funds from operations (FFO) to total debt to decrease to 8.1% compared to 11.3%. Our expectation is that credit metrics will continue to improve in the near term--albeit at a slower pace than historical years--and that financial policies will remain very aggressive.

Our forecast assumptions for 2013 include:

-- Total revenue growth in the mid-single digits, resulting from a combination of new store development and low-single-digit same-store sales;

-- Some increases to capital expenditures to support store growth; and

-- Debt reduction limited to amortization.

Liquidity

We assess Leslie's liquidity as "adequate," with sources of cash likely to cover its needs over the next 12 to 18 months. Cash sources include excess cash on hand, FFO, and availability under its revolving credit facility. We anticipate that cash uses will be modest and consist of capital expenditures, some investment in working capital, and debt amortization.

Relevant aspects of the company's liquidity profile, based on our criteria, are as follows:

-- We expect the company's sources of liquidity will exceed its uses by 1.2x or more over the next 12 months;

-- We also expect net sources would be positive, even with a 15% drop in EBITDA;

-- Sound relationships with banks; and

-- No meaningful near-term maturities and manageable term loan amortizations.

On an annual basis, we expect Leslie's to generate positive free cash flow. However, the company has to manage its weak seasonal cash flow in the fall and winter seasons and its inventory investment when heading into the spring and summer months. The company generates the majority of its cash flow in the fiscal third quarter and thus has its peak liquidity at the end of that period.

Recovery analysis For the full recovery analysis, please see the recovery report on Leslie's, to be published after this report on RatingsDirect.

Outlook

The stable outlook reflects our expectation that the company will continue to open new stores and increase profits over the next 12 months. Although credit metrics could improve modestly during the same period, we anticipate credit ratios will remain reflective of a highly leveraged financial risk profile. We anticipate debt leverage to fluctuate from the mid-4x to mid-7x area as the company continues to grow its profitability and issue additional dividends.

We could lower the ratings if performance turns negative, leading to a change in our assessment of the business risk profile and a deterioration of credit ratios such that EBITDA interest coverage declines below the 1.5x area. Assuming no changes to debt, EBITDA would need to decline 20% below our expectations, under this scenario.

Although unlikely in the near term, we could raise the ratings if the company's financial policies become less aggressive such that debt leverage would be sustainable below the 5x area. For this to occur, approximately $250 million of debt reduction would be necessary with constant EBITDA.